The surge in inflation has shocked
Officials who’ve tried to concoct
A tale that high prices
Don’t mean there’s a crisis
But lately those views have been mocked
Just yesterday, CPI showed
Inflation’s begun to explode
Will Powell respond?
Or is he too fond
Of QE, his bonds to unload?
I am old enough to remember when rising used car prices and their impact on inflation were considered an aberration, and thus transitory. Back in the summer of…’21, better known as the good old days, when CPI prints of 5.4% were allegedly being distorted by the temporary impact of the semiconductor shortage which significantly reduced new car production and drove demand into used vehicles. However, we were assured at the time that this was an anomaly driven by the vagaries of Covid-19 inspired lockdowns and that it would all soon pass. In fact, back in the day, the Fed was still concerned about deflation.
Well Jay, how about now? Once again, I will posit that were I the current Fed Chair, I wouldn’t accept renomination even if offered as I would not want to be at the helm of the Fed when inflation achieves 1970’s levels while growth slows. And, as inflation has become topic number one across the country, so much so that President Biden stated, “Reversing inflation is a top priority,” the Fed is set to be in the crosshairs of every pundit and politician for the next several years. One can’t help but consider that both vice-chairs, Clarida and Quarles, leaving ASAP is analogous to rats fleeing a sinking ship. The Fed, my friends, has a lot of problems ahead of them and it remains unclear if they have the gumption to utilize the tools available to stop the growing momentum of rising inflation.
And that is pretty much the entire market story these days; inflation – how high will it go and how will central banks respond. Every day there is some other comment from some other central banker that helps us evaluate which nations are serious about addressing the problem and which are simply paying lip service as they allow, if not encourage, rising inflation in order to devalue the real value of their massive debts.
As such, we get comments from folks such as Austria’s central bank chief, and ECB Governing Council member, Robert Holzmann, who explained that all ECB asset purchases could end by next September. While that is a wonderful sentiment, at least for those who believe inflation is a serious problem, I find it very difficult to believe that the rest of the ECB, where there reside a large cote of doves, are in agreement. In fact, the last we heard from Madame Lagarde was her dismissal of the idea that the ECB might raise rates anytime soon, admonishing traders that their pricing for rate hikes in the futures markets was incorrect.
The takeaway from all this is the following; listen to what central bank heads say, as a guide to their actions. While not always on target (see BOE Governor Andrew Bailey last week), generally speaking if the central bank chief has no urgency in their concern over an issue like inflation, the central bank will not act. Given the pace of inflation’s recent rises, essentially every central bank around the world is behind the curve, and while some EMG banks are trying hard to catch up, there is no movement of note in the G10. Look for inflation to continue to rise to levels not seen since the 1960’s and 1970’s.
So, how are markets digesting this news? Not terribly well. At least they didn’t yesterday, when equity markets fell around the world along with bond markets while gold and the dollar both soared. However, this morning we have seen a respite from the past several sessions with equity markets rebounding in Asia (Nikkei +0.6%, Hang Seng +1.0%, Shanghai +1.1%) and Europe (DAX +0.1%, CAC +0.1%, FTSE 100 +0.4%) albeit with Europe lagging a bit. US futures are also firmer led by the NASDAQ (+0.7%) but with decent gains in the other indices. Of course, the NASDAQ has been the market hit hardest by the sharp rally in bond yields, so on a day where the Treasury market is closed thus yields are unchanged, that makes a little sense.
Speaking of bonds, yesterday saw some serious volatility with 10-year Treasuries eventually settling with yields higher by 11bps. Part of that was due to the 30-year Treasury auction which wound up with a more than 5 basis point tail and saw 30-year yields climb 14bps on the day. But not to worry, 5-year yields also spiked by 13bps, so it was a universal wipe-out. This morning, in Europe, early bond losses (yield rises) have retreated and the big 3 markets, Bunds, OATs and Gilts, are little changed at this hour. But the rest of Europe is not so lucky, especially with the PIGS still under pressure. I guess the thought that the ECB could stop buying bonds at any time in the future is not a welcome reminder for investors there.
Commodity prices, too, were whipsawed yesterday, with oil winding up the day lower by more than 4% from its morning highs. This morning, that trend continues with WTI (-0.9%) continuing lower on a combination of weakening growth expectations and rising interest rates. NatGas has rebounded slightly (+2.5%) but is now hovering around $5/mmBTU, which is more than $1 lower than we saw during October. It seems that some of those fears have abated. Gold, however, continues to rally, up another 0.4% today and about 4% in the past week. Perhaps it has not entirely lost its inflationary magic.
And finally, the dollar continues to perform very well after a remarkable performance yesterday. For instance, yesterday saw the greenback rally vs every currency, both G10 and EMG, with many seeing declines in excess of 1%. ZAR (-2.6%) led the EMG rout while NOK (-1.65%) was the leader in the G10 clubhouse. But don’t discount the euro having taken out every level of technical support around and falling 1%. This morning that trend largely continues, with CAD (-0.55%) the worst performer on the back of oil’s continued weakness, but pretty much all of the G10 under the gun. In the emerging markets, however, there are some notable rebounds with ZAR (+1.5%) and BRL (+1.0%) both rebounding from yesterday’s movements. The South African story has to do with the budget, which forecast a reduction in borrowing and maintaining a debt/GDP ratio below 80%, clearly both positive stories in this day and age. The real, on the other hand, seems to be benefitting from views that the central bank is going to tighten further as inflation printed at a higher than expected 10.67% yesterday, and the BCB has been one of the most aggressive when it comes to responding to inflation.
With the Veteran’s Day holiday today (thank you all for your service), banks and the Fed are closed, but markets will remain open until 12:00 and then liquidity will clearly suffer even more greatly. There is no data nor speakers due, so I expect the FX market to follow equities for clues about risk. In the end, the dollar is on a roll right now, and I don’t see a reason for that to stop in the near term. Later on? Perhaps a very different story.
Good luck and stay safe